HC's 50% assets threshold for indirect transfers - Setting controversy at rest?


The recent Delhi High Court judgment, setting a 50% Indian assets threshold for invoking taxability on offshore sale, is significant on many counts, not least for bring a semblance of clarity in an otherwise grey zone. Sec 9(1)(i) of the Act read with Explanation 5, introduced by Finance Act, 2012, sought to overrule the Apex Court judgment in Vodafone, by bringing indirect transers into the tax net if 'substantial' assets are located in India. But while doing so, the Legislature left the term "substantially", undefined.

Has the Delhi HC put an end to the controversy over indirect transfers taxation, especially the definition of the term 'substantially'? Will it end the confusion on how to define the term 'substantially, or are there still some unanswered questions'? Is the HC right in taking the aid of Shome Committee report, OECD & UN Model conventions to set a 50% assets threshold? Is it high time for CBDT to come up with a clarification or should the Revenue let the matter rest by accepting the High Court interpretation? 

Gautam Doshi
Group MD, Reliance ADAG

At the outset, it must be realized that the interpretation of the Explanation to Sec 9(1) (i) in the case of Copal Research may be held to be by way of “obiter” and hence not binding. In Para 22, the Hon’ble Court has held that the sale of shares by companies based in Mauritius was for “commercial reasons” and was not made “only to avoid tax”. Hence, the selling companies were entitled to exemption under the DTAA between India and Mauritius. It was therefore, unnecessary for the Hon’ble Court to consider on merits whether; if the sale of shares was the sale of shares of a Jersey Company, it would have been taxable in India.

However, the Hon’ble Court has used the opportunity to explain the provisions of Explanation 5 to Sec 9 (1)(i). It needs to be respectfully, noted that the Hon’ble Court has been able to harmonize Explanation 5 as a “clarification” and not an “extension of the charge to tax”. This is a very significant move which the Revenue will welcome. The Hon’ble Court has thus interpreted the Explanation as an Explanation and therefore, referred to the substance of what the Explanation seeks to...

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T. P. Ostwal
T. P .Ostwal and Associates, Chartered Accountants

"The Delhi HC is justified in taking such a view. In my opinion, the Government ought to have defined this term under the statute , rather than leaving it open for interpretation. It was high time that this matter should have been given full attention , as every representation in last two years on the proposal in the Finance Bill, from every major organisation worth naming, had this representation . But the Government did not have courage to clarify the wrong doing of one Finance Minister. Now, therefore in the policy paralysis situation only courts can resolve the matter as it did in this particular case. The court was very reasonable to say "substantially" means more than 50% interest.


In my opinion, it should have been other way round that is something less than 100%, can be substantial.. say 90% or 95% interest in a property situated in India and not 50%."

Girish Vanvari
Partner, Co-head of Tax, KPMG

There has been a good deal of controversy relating to the scope and applicability of the retrospective amendments, the key issue was undoubtedly the meaning and scope of the term ‘substantially’. The decision of the Delhi High Court in the Copal Research case is undoubtedly one of the most important decisions on the tax front this year as it is the first authoritative pronouncement on this issue.


The key ratio of the judgment is that gains arising from sale of a share of a company incorporated overseas, which derives less than 50% of its value from assets situated in India would certainly not be taxable under section 9(1)(i) of the Act read with Explanation 5 thereto.


It is apparent from the above that the Court has not set out a specific percentage which, if crossed, would automatically trigger the liability under the retrospective amendments. All that it has said is that anything below 50% would not satisfy the test of substantiality. The approach of the Court is certainty interesting- while it precludes the department from seeking to levy tax in cases where the value of assets in India is less than 50% of the total assets, it does not preclude a taxpayer...

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Rajendra Nayak
Partner, International Tax Services , EY LLP

The Finance Act, 2012 amended the Income-tax Act, 1961 under which an “indirect transfer” of an Indian company is sought to be taxed, by providing that a share or interest in a company or entity registered or incorporated outside India would be deemed to be situated in India the share or interest derives, directly or indirectly, its value substantially from assets located in India (indirect transfer taxation rule or the rule). As is common knowledge, the amendment is a sequel to the decision of the Supreme Court in the Vodafone case.


Taxpayers are grappling with numerous issues on scope of the amendment, principal among them being the threshold for measuring “substantial” while applying the rule. This is a crucial requirement for applying the fiction of the rule. The rule contemplates determination of relative value of assets located in India vis-à-vis other assets of the foreign entity whose share/ interest is subject matter of transfer. Since the fiction trigger is linked to substantiality test, question arises as to what meaning needs to be given to the word “substantial” as the term is undefined in the rule. Dictionary meanings as also judicial precedents make it clear that the term “substantial” has diverse shades...

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Sanjay Sanghvi
Partner, Khaitan & Co

Has the Delhi HC put an end to the controversy over indirect transfers taxation, especially the definition of the term 'substantially'?


- Yes, till the time a different view is taken by some other High Courts (HC) or the law is statutorily amended to provide a different threshold, say 26% or 20%, etc., this HC ruling will act as a very helpful judicial precedent on this significant aspect in cross border M&A deals and should be looked upon as a guiding factor in such cases.


Will it end the confusion on how to define the term 'substantially, or are there still some unanswered questions'?


The confusion regarding the definition / value of the term ‘substantially’ should reduce to a large extent (if not completely). However, since the ruling of the HC does not deal with any ‘valuation methodology’ to be adopted to determine whether 50% threshold is breached in a particular case, the confusion surrounding ‘valuation methodology’ would continue to exist.


Is the HC right in taking the aid of Shome Committee report, OECD & UN Model conventions to set a 50% assets threshold?


In my view, the HC is right in drawing support from Dr Shome Committee report, OECD and UN Model Conventions....

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Krishan Malhotra
Head - Taxation, Amarchand & Mangaldas & Suresh A. Shroff & co.

The Delhi High Court’s judgment in case of Copal Research is a welcome judicial development being the first judgment to have delved into the meaning, scope and extent of the term “substantially” in the context of indirect transfers. The High Court has confirmed that the commercial justification provided in the present case is sufficient to demonstrate that prima facie transaction was not structured only to avoid tax. It has also stated that restrictive approach should be employed while interpreting a legal fiction such as Explanation 5 to section 9(1) (i) and concluded that for the indirect transfer tax provisions to apply, the overseas company should derive at least 50% of its value from Indian assets. To reach this conclusion, the High Court relied on the following:


a) Scope of Explanation 5 to section 9(1)(i) should not be extended to tax income that has no nexus with India.


b) The Shome Committee Report and the Direct Tax Code Bill of 2010 both interpreted the term “substantially” to mean a threshold of 50% of the total value derived from Indian assets.


c) Capital Gains tax Article of UN Model Tax Convention as well as The OECD Model Tax Convention on Income and Capital which provide...

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